Is your house an investment?

There are many misconceptions around money and investing that I try and challenge people to re-think everyday.  One of the most common is the perception that property is always a safe investment and a few 'investment' properties will be sufficient for a long and prosperous retirement. A good number (but certainly not all) of my clients come to me in their 40s, they have acquired a house that they live in, they may well have a rental property or two, and they are suddenly worrying about retirement.  They feel safe owning bricks and mortar; society has taught us that owning a home is a path to building wealth.  And whilst certainly real estate can be part of the plan it is important to know that a house is not always a good investment.  I believe we should think of our houses as homes, not investments.  We should purchase the property that is the right home for our family - it is within our means and it is where we want to live.  Overstretching yourself because the house 'seems like a good investment' is generally not a good strategy.

Over the long-run, house prices are tied to inflation, which means a return (in the US) of around 4% since the mid-1920s.  Prices have been relatively stable, but the return doesn't include any of the costs of owning the property.  It is not a given that a families' biggest investment will be their best investment, and often it actually turns into a liability.

house
house

The stock market, on the other hand, has gone up at around 11% over the long-run.  And the wonderful thing about owning stocks instead of property is that they don't need a new a/c system, or a new roof.  They don't get leaks or floods, or have periods of no income because a tenant has left.  People like owning property because they feel it's stable, but the stability only comes from the fact that you cannot get minute-to-minute pricing (like you can with stocks - it's that minute-to-minute pricing that freaks people out).

Ben Carlson recently wrote a blog about the Canadian housing market (which has gone bananas) and in it he quoted Robert Shiller, (housing expert and historian):

"Here is a harsh truth about home ownership. Over the long haul, it’s hard for homes to compete with the stock market in real appreciation. That’s because companies whose shares are traded on a stock exchange retain a good share of their earnings to plow back into the business. The business should grow and its real stock price should also grow through time — unless the company makes poor decisions, as some certainly do.

By contrast, real home prices should decline with time, except to the extent that households shell out some money and plow back some of their incomes into maintenance and improvements, because homes wear out and go out of style."

Perhaps the biggest downside of property is the cost of getting in and out and the fact that you can't get out quickly (it's illiquid).  The trading costs are one of the reasons why most experts recommend buying a property with at least a 7 year time horizon.  Buying a house with the intention of selling in a few years is, in most circumstances, very unlikely to result in you making money (unless you time a boom perfectly).

Of course, I should caveat this by acknowledging that there will always be pockets of opportunity.  Seven Mile Beach has been a hot-spot here for the last few years.  London has been crazy for a decade.

However, living with the mindset that property prices can only go up is a 1990s mentality.  Take the Irish housing market for example - it is still around 30% lower than it was at the 2007 peak.  And that's ten year's later.  To compare, since peaking in 2007 the total return on the US stock market is almost 100%.

I am certainly not saying don't buy property.  We all need a place to live.  My advice in buying property is, instead of asking yourself, what's the most I can afford (or letting the bank tell you how much you can afford), ask yourself the question 'what is the least I can spend on housing and still be happy?'.  When you keep your housing expenses low, it frees up more money to spend on other things day-to-day and in the future.  And it means you can diversify your asset base so that you don't end up with your house being your kids college plan, your retirement plan, and everything in between.